Apple: Goldman Maps ‘Ecosystem’ of Future Sticking Points

By Tiernan Ray

Goldman Sachs’s Bill Shope today reiterates a Buy rating on shares of Apple (AAPL), and raises his price target to $720 from $635, writing that the company’s upcoming Worldwide Developer Conference in San Francisco, starting Monday, may bring important additions to the company’s software and services, which, more than hardware, are “The Next Big Thing” for the company, he believes.

Don’t get too preoccupied with hardware alone, he urges:

While upcoming hardware refreshes (i.e., iPhone 6 and TouchID-enabled iPads) are likely to serve as powerful near-term drivers of Apple’s earnings momentum and stock price, platform enhancements such as mobile payments, connected home solutions, and personal health monitors should be far more important for driving switching costs and installed base expansion over time, and this is what will determine if Apple’s cash flow generation can remain robust and substantially increase from current levels.

Shope highlights his expectations for WWDC topics:

We believe the event will be centered on Mac and iOS software refreshes, iOS platform enhancements, with some minor Mac refreshes being the only hardware-centered announcements. More specifically, we believe it is likely that we will see (1) iOS 8 preview and beta release; (2) the next version of OS X for the Mac, with a beta release; (3) Internet of Things sub-platforms (likely related to personal health and the connected home); (4) standard Mac refreshes; and (5) a more detailed discussion of the recent Beats acquisition. Meanwhile, we believe it is possible, though less likely, we will see (1) enhanced third-party app support for Siri and (2) third-party support for TouchID commerce APIs.

More important, to Shope, is his “framework” for thinking about software and services.

He declares Apple “rarely rests on its platform laurels,” and attempts to show how successive services — iTunes, then App Store — have helped the company maintain loyalty to its hardware devices:

As smartphones and tablets have subsumed once stand-alone categories of compute, portable media players, and mobile telephony, they have also become hubs for the various sources of platform value these categories depended on. Apple’s evolution as a company has been partially shaped by this process over the past decade: (1) the iPod platform was intricately dependent upon media content, with iTunes representing the primary delivery mechanism for this content; (2) the smartphone subsumed this functionality, and Apple was able to link-and-leverage its iTunes dominance to give the iPhone a head start in this burgeoning market opportunity; (3) with the emergence of the App Store and bite-sized, mobile-centric apps, iPhones began to capture the personal compute functionality once reserved for Macs and PCs; and (4) the iPad took this to the next level, abruptly changing the personal computing industry landscape. Apple’s rapid growth also tightly followed this evolving industry narrative (Exhibits 3 and 4).

Here is Shope’s chart of how App Store took over from iTunes just as non-DRM music was eroding the lock-in of iTunes:

As for what’s next, Shope writes a kind of map of the Apple ecosystem:

The concentric circles in the exhibit below contain three levels, with the operating system at the core. On the outermost level, are what we view as eight viable sources of switching costs and customer value for mobile ecosystems. In the middle layer, we illustrate the mechanism that ties the core to the switching costs. For example, for entertainment media to become a source of platform stickiness, the ecosystem needs to have content deals in place (e.g., with record labels, film studios) and a consumption mechanism. In Apple’s case, iTunes and the iTunes Music Store have served that purpose. Similarly, the iOS software development kit (SDK), developer tools, and the App Store were what made iOS a capable platform for mobile compute. By the same token, we saw iCloud and Siri as gateways to new switching costs related to user-generated content (e.g., Photo Stream, iWork for iCloud, syncing of contacts and calendars) and search more generally. But for iCloud and Siri to truly enhance the platform, they need to substantially distinguish themselves from existing competitors, which in our view has not happened yet. We also see several potential sources of switching costs where Apple has barely scratched the surface, for example social networking, payments, and physical monitors (e.g., iWatch). Although we would be encouraged by developments in these areas, we believe it is important to remember that these should be primarily platform enhancements rather than revenue replacements. It would clearly be a mistake to underestimate Apple’s ability to innovate and succeed in some of these opportunities for platform enhancement. With that said, Siri and iCloud have taught us that not all innovations can provide Apple with substantial differentiation. In addition, with a rapid pace of innovation from competitors such as Google, Apple now faces a larger hurdle than it did with its iTunes and App Store launches. Nevertheless, innovations in areas like mobile payments and personal monitors (Internet of Things more broadly) could begin to reinvigorate Apple’s platform differentiation and stimulate overall device growth.

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There are 7 comments

MAY 30, 2014 2:49 P.M.

Thomas Wolf wrote:

It takes this Goldman analyst until 2014 to see the exponential growth and huge margins for Apple's App Store and, based on this "revelation", raise his price target? Well done, Captain Obvious!

MAY 30, 2014 2:50 P.M.

Sheeshasaurus wrote:

Isn't Bill or Katy going to ask Will.i.am or Jimmy what the next big thang is? People are always speculating. Yet no one ever gets it right. I want to know. What's the next big thang huh.

MAY 30, 2014 3:20 P.M.

Ed wrote:

You know when Shope, The Snake from GS, raises Apple PT, that means sell as fast as you can. He will F you over like he always does, just like today.!

MAY 30, 2014 3:23 P.M.

Peter wrote:

Bill Shope is the Judas of Wallstreet. When he says Buy Apple, that means sell as fast as you can. He will stick it up your as_ trust me. See now.

MAY 30, 2014 3:31 P.M.

Ron wrote:

Shope, Reitzes, and Gillis. The 3 Stooges on Apple.

MAY 30, 2014 6:55 P.M.

@ Ed Bill Ron wrote:

GS is maybe among the top 5 holders of Apple; long. That doesn't mean they'll ever pass on a short term opportunity, they're a playful bunch: You should expect and anticipate that. You should exactly know the various conditions and playbook they have avail to and knowledge of. This is not for kids. And if it looks like too much of a good thing is a good thing expect bang them to play it both ways. It's the same road. That said. Learn.

MAY 30, 2014 7:02 P.M.

Anonymous wrote:

I wish Simona Jankowska from GS covered Apple. She's my favourite Analyst. But so was Meeker and now KH at MS.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.